TLDW: no matter what the "market cap rate" is, ensure your "deal cap rate" is above the loan interest rate (or to be more correct, above your lender's yield aka loan constant since you don't pay back just the interest but also a part of the principal), by either negotiating for a better price (or looking for another better priced deal) or doing something to raise the NOI, or both.
I have heard about the cap rate before but Paul has made this easy for me to understand. The other explanations included a lot of financial terms that probably made the presentation more accurate, but if you don't understand the basic concept it is largely useless on a practical level. Now I have to go look at your older episodes to see what else I have missed.
That's interesting, I've never heard of Cap Rate in the UK. Did some research and many forums are saying this is getting more and more popular with Real Estate in the UK. Definitely need to do more studying on this!
Yes Paul, YOU ARE A SUCH A GOOD PERSON 😅 I’m just learning from you guys about real estate, I know it’s one of the quickest ways to get more profitable but I never look at it... Thanks for your sharing
Great example , but not to forget considering the current interest rate environment. Assuming even if your mortgage rate = cap rate still it may make sense to buy the property as after sometime you will end up owning the property than living in a rented property for decades and not owing anything. So the best strategy is buying the dip but owning something is also really important.
This is a great video. I would agree that people have difficulty understanding cap rates in general and many struggle until they have that "aha!" moment. It is a simple concept but also abstract in a way. I am a PE investor who does a lot of real estate and a friend asked me to explain to her the relationship between cap rates and interest rates (for a project she was working on) and even though I understand the relationship, it was hard to explain it to her in a way that she could understand. Found this video and the lightbulb went off for her! You have gained a subscriber!
Great basic explanation! Its the math simple enough to determine your net income by subtracting your interest rate on your financing from the cap rate and multiply that percentage by the net income?
It's not exactly a 1:1 ratio. Start with the 10-year treasury. It's at 4.6% today. If I had $1mm, I could earn $46,000 per year for the next 10-years with virtual risk-free return and get my $1mm back regardless of what interest rates did along the way. Of course, I would pay 25% tax on that. Having that, if I wish to take on additional risk by purchasing a multi-family unit building, I demand a better return. Perhaps I ask for +1.5% better than the 10-year treasury rate. This would make my going-in CAP rate 6.1%. When used against the seller's NOI, it would give the offer price. Over 10-years, rents will go up. mortgage gets paid down, interest rates may come down (CAP comes down too), and your selling price goes up. Also, you pay little tax along the way (if any). So, for assuming a little risk, you can 4x your down payment along the way. Just start with the 10-year treasury yield.
Not a metric we use much in the U.K. We use ROCE or Return on capitol employed more. Possibly because we tend to get a far lower return as far as I can see lol... Great work guys. Thank you.
What i got from this video is "the more i overpay, the less the profit margin, the longer time to reach goals" it so simple im not sure i got it right.
You mean a house as a rental? The same way. Revenue less expenses and then take that and divided by the purchase price plus any remodeling expense you may have - PG
Well you have to remember in the early 1980s, we had massive inflation in the way to fight it was by raising rates so high. So to unwind that takes a very long time and that’s why rates can go down for so long. When will they increase? I have no idea. Why would they increase? Well theoretically if the job market or inflation gets too hot, they would increase to decrease it but they didn’t do that last year so who knows? PG
Sorry, but as a real estate investor myself, you are creating misinformation. Cap rate is a measure of market sentiment on an investment in a particular location. More desirable areas in general have a lower cap rate than a less desirable area. No different than a person willing to pay more for a house in a nicer neighborhood and less for a similar one in the slums regardless of interest rates. Cap rate by definition does not account for debt services. You keep trying to mix the 2. As an investor, yes, you would care about cap rate and interest rate if you have to borrow. But by pure definition, they are completely separate things.
Of course cap rate does not account for debt services but that does not mean they dont work together. Thats like saying net income doesnt account for debt service but you shouldnt consider it. As interest rates go up, you need more net income to cover debt service, so thats the same as cap rate needing to go up. Your statement doesnt look at the domino effect. - PG
This is def not misinformation and its misinformation to say what you said. I do appreciate you being calm about it but cause and effect is clear in cap rates and debt rates. If you have a cap rate of 4%, do you need your debt to be higher or lower than 4% to make money? And vice versa. To say they arent connected is misguided and lacks understanding in how real estate prices go up and down. Look at where cap rates have gone since 1985. Is it a coincidence that as rates have gone down, cap rates have as well? Its not. - PG
@@EverythingMoney You are overemphasizing 2 rates that don't couple as tightly as you think. You can certainly make money with higher interest rate than cap rate. I've done it and it's how most investors make money in real estate. Why? Because cap rate is a measure of what people are willing to pay for an investment regardless of interest rates. If you go by straight cap rate vs interest rate, you'll have a tough time finding deals. You find value in an investment because you believe NOI can be significantly improved either due to better management, increasing revenue, or reducing OpEx or a combination of all those. And you're willing to pay the lower cap rate even if interest rate is higher. The cap rate compression as a result of improving your NOI is what adds value to your investment. Your type of thinking is why most new investors pass up on good opportunities because they simply say interest rate > cap rate so it's not a buy.
That’s one way of doing it. I’ve had this conversation before with many people and I think we just move on from it because they absolutely disagree that they do not correlate together. But I appreciate you talking very professionally with me and I hope you continue to watch the videos and engage us as well. PG
@@EverythingMoney I have to agree with PG on this one, although @SCH LLC makes a good point in terms of location and what people are willing to pay for a deal, I think the crux here stand at one opinion is more investment focused (PG) and the other is more speculation focused. When you acknowledge the interest rate impact on CAP from the outset prior to any forced or organic market appreciation you are prudently investing when you do not you are speculating on asset prices. IMHO. Thanks for the dialogue in advance. P.S Paul what were the 6 parameters , I'm new to the channel and would like to participate.
TLDW: no matter what the "market cap rate" is, ensure your "deal cap rate" is above the loan interest rate (or to be more correct, above your lender's yield aka loan constant since you don't pay back just the interest but also a part of the principal), by either negotiating for a better price (or looking for another better priced deal) or doing something to raise the NOI, or both.
I have heard about the cap rate before but Paul has made this easy for me to understand. The other explanations included a lot of financial terms that probably made the presentation more accurate, but if you don't understand the basic concept it is largely useless on a practical level.
Now I have to go look at your older episodes to see what else I have missed.
Check them out :-) thanks so much for the compliment. - PG
That's interesting, I've never heard of Cap Rate in the UK. Did some research and many forums are saying this is getting more and more popular with Real Estate in the UK. Definitely need to do more studying on this!
Yes, this is just a way of understanding the profit vs the price/investment no matter where you are! I am glad you found it. - PG
@@EverythingMoney Yeah man! Learn something new everyday!
That’s the only way to live. PG
I finally get it..light 💡 moment. Thx much
Yes Paul, YOU ARE A SUCH A GOOD PERSON 😅
I’m just learning from you guys about real estate, I know it’s one of the quickest ways to get more profitable but I never look at it...
Thanks for your sharing
Ha thanks Marco! Thats very kind of you to say - PG
Great example , but not to forget considering the current interest rate environment. Assuming even if your mortgage rate = cap rate still it may make sense to buy the property as after sometime you will end up owning the property than living in a rented property for decades and not owing anything.
So the best strategy is buying the dip but owning something is also really important.
Great examples
This is a great video. I would agree that people have difficulty understanding cap rates in general and many struggle until they have that "aha!" moment. It is a simple concept but also abstract in a way. I am a PE investor who does a lot of real estate and a friend asked me to explain to her the relationship between cap rates and interest rates (for a project she was working on) and even though I understand the relationship, it was hard to explain it to her in a way that she could understand. Found this video and the lightbulb went off for her! You have gained a subscriber!
Great basic explanation! Its the math simple enough to determine your net income by subtracting your interest rate on your financing from the cap rate and multiply that percentage by the net income?
Where are the videos where you guys analyze deals and talk about cap rates? Great video btw thank you!
Show us Uncle Paul!! Whoop!
Great video!
Great information
Thanks Gil! - PG
Thank you
What should the ratio be ? If interest rate is 7 what should minimum cap rate be ?
It's not exactly a 1:1 ratio. Start with the 10-year treasury. It's at 4.6% today. If I had $1mm, I could earn $46,000 per year for the next 10-years with virtual risk-free return and get my $1mm back regardless of what interest rates did along the way. Of course, I would pay 25% tax on that.
Having that, if I wish to take on additional risk by purchasing a multi-family unit building, I demand a better return. Perhaps I ask for +1.5% better than the 10-year treasury rate. This would make my going-in CAP rate 6.1%. When used against the seller's NOI, it would give the offer price. Over 10-years, rents will go up. mortgage gets paid down, interest rates may come down (CAP comes down too), and your selling price goes up. Also, you pay little tax along the way (if any). So, for assuming a little risk, you can 4x your down payment along the way. Just start with the 10-year treasury yield.
Not a metric we use much in the U.K. We use ROCE or Return on capitol employed more. Possibly because we tend to get a far lower return as far as I can see lol... Great work guys. Thank you.
Thanks Mark! - PG
This was great
What i got from this video is "the more i overpay, the less the profit margin, the longer time to reach goals" it so simple im not sure i got it right.
Ha basically thats right - PG
@@EverythingMoney cool cool. You are good at traching. Have you thought about writing an ebook?
Uh oh. Ha. Dont tell my friend Matt what you said. He has been trying to get me to do it for a while. - PG
@@EverythingMoney XD, no surprise.
How can one find the cap rate when purchasing a house? Thank you
How one find the cap rate when purchasing a house ? Thank you
You mean a house as a rental? The same way. Revenue less expenses and then take that and divided by the purchase price plus any remodeling expense you may have - PG
@@EverythingMoney thank you
Great vid!!
Thanks so much! Did you subscribe!? - PG
@@EverythingMoney Of course. Ive been subscribed for over 2 months and love the content
Thats awesome. Does an app sound interesting to you? - PG
What are you paying less on?
Y’all are funny 😂
His problem is that a cap rate is not a "return"! That makes everything he says clueless!
When and why will the fed increase interest rates again? Why have they continued to fall for so long?
Well you have to remember in the early 1980s, we had massive inflation in the way to fight it was by raising rates so high. So to unwind that takes a very long time and that’s why rates can go down for so long. When will they increase? I have no idea. Why would they increase? Well theoretically if the job market or inflation gets too hot, they would increase to decrease it but they didn’t do that last year so who knows? PG
❤🇨🇷🇨🇷🇨🇷🇨🇷
Sorry, but as a real estate investor myself, you are creating misinformation. Cap rate is a measure of market sentiment on an investment in a particular location. More desirable areas in general have a lower cap rate than a less desirable area. No different than a person willing to pay more for a house in a nicer neighborhood and less for a similar one in the slums regardless of interest rates. Cap rate by definition does not account for debt services. You keep trying to mix the 2. As an investor, yes, you would care about cap rate and interest rate if you have to borrow. But by pure definition, they are completely separate things.
Of course cap rate does not account for debt services but that does not mean they dont work together. Thats like saying net income doesnt account for debt service but you shouldnt consider it. As interest rates go up, you need more net income to cover debt service, so thats the same as cap rate needing to go up. Your statement doesnt look at the domino effect. - PG
This is def not misinformation and its misinformation to say what you said. I do appreciate you being calm about it but cause and effect is clear in cap rates and debt rates. If you have a cap rate of 4%, do you need your debt to be higher or lower than 4% to make money? And vice versa. To say they arent connected is misguided and lacks understanding in how real estate prices go up and down. Look at where cap rates have gone since 1985. Is it a coincidence that as rates have gone down, cap rates have as well? Its not. - PG
@@EverythingMoney You are overemphasizing 2 rates that don't couple as tightly as you think. You can certainly make money with higher interest rate than cap rate. I've done it and it's how most investors make money in real estate. Why? Because cap rate is a measure of what people are willing to pay for an investment regardless of interest rates. If you go by straight cap rate vs interest rate, you'll have a tough time finding deals. You find value in an investment because you believe NOI can be significantly improved either due to better management, increasing revenue, or reducing OpEx or a combination of all those. And you're willing to pay the lower cap rate even if interest rate is higher. The cap rate compression as a result of improving your NOI is what adds value to your investment. Your type of thinking is why most new investors pass up on good opportunities because they simply say interest rate > cap rate so it's not a buy.
That’s one way of doing it. I’ve had this conversation before with many people and I think we just move on from it because they absolutely disagree that they do not correlate together. But I appreciate you talking very professionally with me and I hope you continue to watch the videos and engage us as well. PG
@@EverythingMoney I have to agree with PG on this one, although @SCH LLC makes a good point in terms of location and what people are willing to pay for a deal, I think the crux here stand at one opinion is more investment focused (PG) and the other is more speculation focused. When you acknowledge the interest rate impact on CAP from the outset prior to any forced or organic market appreciation you are prudently investing when you do not you are speculating on asset prices. IMHO. Thanks for the dialogue in advance. P.S Paul what were the 6 parameters , I'm new to the channel and would like to participate.